6th October 2016

The tide hasn’t turned

MARKET CLOSE:
FTSE 100
7,033, -41
DAX
10,586, -34
S&P 500
2,159, +9
iTraxx Main
73.5bp, unchanged
iTraxx X-Over Index
332bp, unchanged
10 Yr Bund
-0.01%, +5bp
iBoxx Corp IG
B+125bp, -1bp 
iBoxx Corp HY Index
B435bp, -5bp
10 Yr US T-Bond
1.72%, +3bp

You cannot be serious…

Draghi1

“We will do whatever it takes” – Draghi on July 26, 2012

“Read my lips (sic)… we will do whatever it takes.”

Tapering of the ECB’s bond purchase programme anytime soon – that is, say the next 12 months – would be akin to throwing in the towel and reneging on that statement which Draghi famously made. It is not a case of “job done”.

There’s no Eurozone recovery and we certainly don’t see the whites of the eyes of a recovery. In fact, there’s little prospect of a definitive sustainable trend emerging to suggest that that we might be in the early stages of one. We’re hooked on easy money, it’s necessary and we’re likely going to see QE ongoing in some form or other for the medium term.

It is so tempting to throw in the usual trade from the recent back up in prices (higher yields) and suggest we have a good entry point. Maybe we do, except that we are already so over-exposed to duration risk at historical crazy levels, that few will really want to add more to their positions here.

We still happen to believe that the 10-year Bund yield will see -0.20% before it sees +0.20% again, and after dropping to -0.16% intraday last week, the current level looks tempting. No need to rush, there is going to be a little market apprehension now until we get some words of comfort from Draghi himself.

And finally, we had a deal in IG non-financials as Italian utility Terna pulled the trigger on a 12-year for €750m, some 15bp inside initial price talk on a day otherwise dominated by a plethora of SSA issuance. The Terna deal was the first this month amid some disappointment already that we haven’t had much more in these opening skirmishes. Air France-KLM piped up for the HY market in an increased €400m deal to yield 3.75%, with Alliance Automotive in for a €180m tap of the 2021s.

May throws a potential spanner in the works

So, Prime Minister May acknowledged in her conference speech the “bad side effects of monetary policy” while appreciating its necessity in an emergency. With change needing to come, as she suggested, we have a little to think about here on the back of a potential clash with the BoE.

Unhelpful comments indeed for those long-duration positions. The conspiracy theorists will add these to the reports of potential ECB tapering to come up with the view that monetary policy has run – or is close to running – its course and usefulness, and something new and radical is necessary. Is the patient’s cold turkey moment coming?

Anyway, to address it and/or rebalance it, is looser fiscal policy coming? Perhaps, but surely not enough to offset the benefits of lower rates or a proper, long-term structural shift in policy and thinking (which means some pain for everyone is coming). As result, we saw a back up in yields again, and in the end it was as bad as what we experienced in Tuesday’s session. The 10-year Gilt yield backed up to 0.81% (+4bp).

What goes down, must come up

The yield story rumbled on and the Bund moved to yield d-0.01% (10-year), some 5bp higher in the session to add to that of the 5bp of weakness in yield in the session before. In the periphery, Italian 10-year yields were 5.5bp higher at 1.36% and Spanish ones at 1.03% (+6bp). Just to think that just a couple of sessions ago, Spanish Bonos in 10-years were at record lows of 0.89%.

The US delivered a bunch of upbeat data too, with manufacturing activity on the up and the service sector gong gangbusters according to the ISM report. Treasury yields backed up, with the 10-year at 1.72% (+3bp) into much chatter about the potential for a rate rise at the next FOMC meeting in early November.

Equities in Europe were left mainly in the red, although the US was in positive territory and that might auger well for today’s session. Lower than expected US crude inventories gave oil prices a boost and Brent moved around 2% higher to a heady $52 per barrel. Only a week or so ago, we were trading off a $44 per barrel handle.

Any hesitation that was being felt in government bonds or European equities wasn’t felt in the secondary corporate bond market, where we saw a slight tightening in spreads (finally), and the Markit iBoxx index left at B+125bp (-1bp). Underwhelming issuance of late, coupled with the ECB’s ongoing interest, leaves this as maybe a sign we’re going to tighten up. Fingers crossed.

Similarly, the high yield market saw some decent performance, some 5bp tighter at B+435bp – and the biggest move lower we’ve seen for many weeks. The indices closed out in pretty much unchanged territory with Main at 73.5bp and X-over at 332bp.

We’re into the non-farm payroll slipstream. What are the chances that we see little activity today? Have a good day. Back tomorrow.

Suki Mann

A 25-year veteran of the European corporate bond markets and in his role as Credit Strategist, Dr Mann has been ranked number one in the Euromoney Investor Survey eight times in ten years. Previously with Societe Generale and UBS, he now shares views of events in the corporate bond market exclusively here on Credit Market Daily.